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A city isn't eligible for a bankruptcy makeover unless it shows that key steps were met, especially good-faith talks with creditors earlier this year.

Trial to examine if Detroit eligible in bankruptcy

By: tessa.anderson October 23, 2013Comments Off on Trial to examine if Detroit eligible in bankruptcy

The city of Detroit for months has disclosed the awful condition of its finances. Now it’s up to a judge to determine if the largest public bankruptcy in U.S. history really can go forward.

An unusual trial starts Wednesday, pitting Detroit’s emergency manager and his legal team against unions and pension funds that claim the city isn’t qualified to scrub its books clean under Chapter 9 bankruptcy.

A city isn’t eligible for a bankruptcy makeover unless it shows that key steps were met, especially good-faith talks with creditors earlier this year. It’s a critical decision for Judge Steven Rhodes: If Detroit clears the hurdle, the case then would quickly turn to how to solve at least $18 billion in debt and get city government off the ropes.

“It’s a crucial point in the case,” said lawyer Chuck Tatelbaum, a bankruptcy expert in Fort Lauderdale, Fla. “There will be others, but this is the go or no-go. … If there was ever a poster child for what Congress decided when they enacted Chapter 9, it’s for a city like this.”

Jim Spiotto, a bankruptcy expert in Chicago, said it’s “virtually impossible” to argue that Detroit is solvent.

“They’re not paying their debts,” he said. “Look at their blighted areas. Look at their services.”

Nonetheless, unions and pension funds are challenging Detroit on the eligibility question. They claim emergency manager Kevyn Orr, who acquired nearly unfettered control over city finances following his appointment by Michigan Gov. Rick Snyder, was not genuinely interested in negotiating when they met with his team in June and July. Orr insists pension funds are short $3.5 billion and health coverage also needs to be overhauled.

Evidence will show that Orr “planned to file bankruptcy long before the purported negotiations had run their course, confirming that the ‘negotiations’ were no more than a check-the-box exercise on the way to the courthouse,” Babette Ceccotti, an attorney for the United Auto Workers, said in a court filing.

Earle Erman, attorney for Detroit’s public safety unions, said the city has cut wages and changed health care benefits without across-the-table talks. Lawyer Sharon Levine, who’s representing the American Federation of State, County and Municipal Employees, said the city spent months “mapping out its path to Chapter 9,” not looking for compromises that could keep Detroit out of bankruptcy.

In response, however, attorneys for the city said a June 14 meeting and subsequent sessions with creditors were well-intended but fruitless. A bankruptcy filing was being prepared, they acknowledged, but “never set in stone.”

Spiotto said the judge will have much discretion to determine whether the city has met its “good-faith” burden.

The trial in front of Rhodes is expected to last several days, with testimony from Orr, Police Chief James Craig, financial consultants and, possibly, the governor. It will be an autopsy on what Snyder has called decades of ruinous financial decisions in Detroit combined with an exodus of people — the population has dropped to 700,000 from 1.8 million — and other social and economic factors.

“The city’s restructuring must provide a foundation for the city to begin to provide basic, essential services to its residents in a reliable fashion,” Orr said in July when he took Detroit into bankruptcy. “Without this, the city’s death spiral … will continue.”

Orr’s team estimates that 65 percent of Detroit’s annual revenue would be eaten up in debt payments by 2017 without an overhaul in bankruptcy court. Miles away from court, countless streets are bleak: By last spring, at least 16,700 structures were inspected and classified as dangerous. Thousands of streetlights are dark.

Private donors are replacing ambulances that limp around with more than 200,000 miles. The fire department has just one mechanic for every 39 fire vehicles. The number of Detroit parks has dropped to about 60 in recent years from more than 300, due to a lack of money.

University of Michigan law professor John Pottow said unions and pension funds are aggressively challenging the city because they lose leverage if the judge finds the Chapter 9 filing was proper. Detroit would take the lead in coming up with a plan to bring the city out of bankruptcy, putting pensions at risk along with billions owed to other creditors.

“It makes denial and rationalization harder for people who want this to go away,” Pottow said.